IMF/CFP Policy Roundtable on the Future of Financial Regulation

Good morning. It’s a pleasure to be here. I would like to welcome you to the IMF for this policy roundtable on the future of financial regulation. I would also like to thank Dean Anand and Professor Lemma Senbet of the Center for Financial Policy at the University of Maryland for their support in co-organizing this event.

Today an ambitious agenda has been set out covering the future of financial regulation. I would encourage you to be bold in your discussions and challenge the status quo. Such thinking will help ensure that we have a strong and stable financial system for the future. At the upcoming IMF/World Bank Spring Meetings, I will also encourage ministers to advance discussions on the regulatory agenda, which is one of the key policy issues for the G20 Summit in June.

Before turning to such work, I would like to address three key aspects:

Why is it important to discuss strengthening financial regulation?

How successful have reforms been in recent years, and what are the key challenges remaining?

What role can the IMF play in helping to achieve better and stronger financial regulation?

First let me just set the scene briefly on the global economy. It’s fair to say that things are looking a bit better than they did even a few months ago. We can see some signs of thaw—welcome signs after the longest, hardest, winter in a generation.

But we should not delude ourselves into a false sense of security. The recovery is still very fragile. For example, the financial system in Europe is still under heavy strain. In Europe but also elsewhere, debt is still too high, both public and private. In the United States also, the recovery is being held back by the burden of household debt. Some of the statistics here are staggering—for example, about 1.5 million mortgages are seriously delinquent and 22.8 percent of mortgages are “under water.” More must be done to ease that burden.

We need a policy path that strikes the right balance in fiscal and monetary policies to promote stability and growth. And push ahead with structural policies to boost competitiveness and employment.

And we need financial regulation that makes the financial sector safer and puts it back in the service of the real economy. I see two broad dimensions: (i) growth and (ii) stability.

First, it’s about growth. Stronger growth means preventing banks from going into reverse gear, contracting credit in the face of market pressure. Solutions should focus on raising capital levels—rather than cutting back lending—as the way to boost capital ratios. Solutions should also focus on balance sheet clean-up and the shedding of legacy assets. Maintaining orderly funding conditions is also imperative.

Second, it’s about stability. We must break the vicious cycle of banks hurting sovereigns and sovereigns hurting banks. This works both ways. Making banks stronger, including by restoring adequate capital levels, stop banks from hurting sovereigns through higher debt or contingent liabilities. And restoring confidence in sovereign debt helps banks, which are important holders of such debt and typically benefit from explicit or implicit guarantees from sovereigns.

To help achieve the objectives of growth and stability, we need a stronger and safer financial sector that puts societal interest ahead of its own financial gain. This means better, and more coordinated, regulation. We must not let financial regulation slip off the policy agenda. We simply cannot carry on with the financial sector that gave us the global financial crisis. We need a more stable financial system, one that serves businesses and households rather than destabilizes the functioning of the real economy.

What are the key challenges in strengthening financial regulation? Here I see maintaining the reform momentum through cooperation as paramount

In our view, the world is best-served by an internationally harmonized set of standards that are consistently implemented across countries, so as to avoid competitive distortions.

We’ve already come some distance here, notably through the Basel III process. We have broad agreement on higher quality capital and liquidity standards with phase-in arrangements. We also have the recent agreement on policy measures addressing the risks posed by global systemically important banks.

While policymakers have made progress, they still need to complete the reform agenda and ensure that the new standards are implemented in a way that is consistent across countries. We now need effective implementation, in a coordinated manner, of what has been agreed and more agreement on outstanding areas—including regulation of derivatives and the shadow banking system, and effective resolution of banks with cross-border operations.

We also need timetables to be coherent so as not to undermine the resilience of the global financial system. For example, the implementation period for Basel III is up to 10 years and the EU has draft legislation (CRD4) that diverges from Basel III in areas such as definition of capital. There is also uneven progress across sectors with limited progress in the OTC derivatives market reform, cross border resolution, and convergence in accounting standards.

The reform momentum must be maintained. This means better, and more coordinated, regulation and in some cases deeper integration. How do we bring this about? With an inclusive consultative process. For example, concerns have been raised by other economies that there could be a few areas where the pace and content of new US regulations could have unintended consequences for other advanced market economies, based on the current interpretation of the Dodd-Frank Act proposals. The US authorities are seeking to take these concerns into account as they write the corresponding regulation or inform on its interpretation.

In the euro zone, a single financial market cannot rely on legal and institutional frameworks that operate on an asymmetric national basis. To break the feedback loop between sovereigns and banks, we need more risk sharing across borders in the banking system. In the near term, a pan-euro area facility that has the capacity to take direct stakes in banks would help. Looking further ahead, monetary union needs to be supported by stronger financial integration which our analysis suggests be in the form of unified supervision, a single bank resolution authority with a common backstop, and a single deposit insurance fund.

We also need to look beyond advanced countries, and under the Mexico G-20 presidency, work has just commenced on a study of the effect of financial sector regulatory reform initiatives on emerging markets and developing economies. While the Financial Stability Board is in the lead, it will be closely supported by the Fund and World Bank, to produce a report for the June G20 summit. The goal of the study is to facilitate smooth implementation of the globally agreed measures -- not in any way to reopen or dilute them.

Let me conclude by highlighting how the IMF can help...

I see four areas. First, as part of our bilateral efforts, we conduct periodic assessments of the health of financial systems through the so-called Financial Sector Assessment Program, or FSAP, which was launched in response to the 1997-98 Asian financial crisis. Second, as you know, the IMF is also tasked with conducting multilateral surveillance of the international financial sector. Our semiannual Global Financial Stability Report covers emerging risks and vulnerabilities in the global financial system and forms our main multilateral surveillance vehicle. Third, we have been tasked by the international leaders to develop a suitable framework for macroprudential policy and its associated toolkit.

Through this work we will monitor the consistent implementation of financial regulations.

But strong multilateral commitments are also needed to ensure the credibility of the reform agenda and to avoid regulatory arbitrage.

This brings me to the fourth area. Here, the Fund is deeply involved in promoting the design of appropriate international standards for financial regulation and supervision through our engagement with the standard setting bodies and the Financial Stability Board (FSB). And we will take positions on key regulatory issues based on a sound and informed analysis.

Let me finish by welcoming today’s participants who come from a wider array of backgrounds, including academics, policy makers, regulators, private sector participants, and Fund staff. We therefore hope that this roundtable will provide a useful sounding board for our current policy positions and your insights will help us refine our input to the agenda on financial regulation in a forward looking manner.